Isakson On New Mortgage Requirements

Today’s Courier Herald Column:

As we approach the fourth anniversary of the financial collapse caused by the bursting housing bubble, we’re still trying to figure out exactly what we’ve learned.  More specifically, we’re trying to ensure that we don’t repeat the same mistakes.  They are getting quite expensive.

Much as is the case where federal policy intersects a large financial problem, policy makers who previously resisted any effort for the government to head off problems decry the lack of regulation within the affected industry and frantically propose new rules.  These solutions often serve to further exacerbate the problem.

Such is the case with proposed regulations regarding the secondary mortgage market.  The securitization of mortgages has allowed for a nationwide mortgage capital market.  It has allowed banks to rid themselves of long term interest rate exposure while allowing additional capital to be made available to homeowners at historically low rates.  It’s also confused and obfuscated who actually owns mortgage debts, who is responsible for working out issues with homeowners when there is a problem, and has taken any sense of default risk away from those who approve the mortgages.

As such, changes to the system are in order.  At the same time, however, the mortgage market remains a complete function of the federal government.  Roughly 9 of every 10 mortgages made in this country today are backed in some form by the federal government.  Fannie Mae, Freddie Mac, FHA, and the VA have been essential to there being any mortgage market at all for the past 4 years.  Private money has vacated the market except for where the government is willing to backstop risk in these very uncertain times.

Lawmakers are struggling with the best way to reduce the federal government’s role in the market and encourage private investment to return.  Yet they are also still trying to find the right mix of rules and regulations to ensure that the industry rebuilds itself on sound underwriting and credit standards.  There remains natural friction between the two goals.

Georgia Senator Johnny Isakson weighed in via a guest editorial published by the Atlanta Journal Constitution this week.  He has sponsored legislation calling for the phase out of Fannie Mae and Freddie Mac within 10 years to re-establish private risk taking as the primary driver of the mortgage market.  He is also seriously concerned over a proposed regulation that would set a minimum 20% down payment for those purchasing homes if their mortgages are to be bundled into securities and sold in the bond market.  These securitizations remain key if private markets are to be able to maintain low interest rates by allowing investors to assume long term interest rate risks.

The Obama administration, which Isakson credits with adopting his proposal to allow homeowners current on their mortgages to refinance at lower rates regardless of appraisal, wants to require lenders to retain 5% of the risk on mortgages they originate if they allow mortgages with less than 20% down.  While the amount sounds relatively low, it would tie up a significant amount of capital of smaller institutions and continue to expose them not only to credit risk, but also long term interest rate risks.

Sound underwriting of mortgages is a must.  Income documentation and appropriate credit risk must be considered when approving mortgages, as they are the primary determinant of loan repayment.  The amount of down payment, however, is not.  As an example, a comparison of FHA to Fannie Mae illustrates this point.

The Federal Housing Administration has historically allowed home purchases with as low as a 3.5% down payment.  FHA also has some of the most strict documentation requirements for both income and appraisal standards.  They also have steep mortgage insurance premiums on loans with small down payments.  Despite all of the money that taxpayers have sent to bail out Fannie Mae and Freddie Mac, no bailout money has been used on FHA.

Securitized loans need full documentation.  They need to have interest rate pricing and mortgage insurance commensurate with the credit risk.  Borrowers need to be able to document their ability to repay.  If they do this, FHA has demonstrated that they do not also need to put 20% down to purchase a home.

Isakson literally grew up in the housing business.  He’s also spent a career helping make government policy.  He is where the two fields intersect.  On the matter of down payments and the future of securitized mortgages, Isakson has this one right.

17 comments

  1. John Konop says:

    I sound like a broken record on this issue, I have said it for years. The loan amount should be based on rental value. If a person can rent the property for the loan value less time value of payments it is very secure loan. Any dollar above that is risk and tax payers should not be in the risk business.

    • notsplost says:

      That is a very interesting proposal and I tend to agree with it. Actually I think that the taxpayers should not be in the risk business period. But in the current environment that isn’t politically feasible yet, so this would be the next best thing.

  2. CobbGOPer says:

    Perhaps Isakson can also work to help homeowners in Georgia who were screwed by the banks on forclosures? I don’t know, maybe he could talk to his old friend Mr. Deal to convince him to use the $100 million we got in the federal settlement FOR WHAT IT IS ACTUALLY INTENDED TO DO.

    As opposed to basically stealing every cent so he can focus on luring more businesses to Georgia to ‘create’ jobs; never mind that so many simply take the tax breaks and then hire people from elsewhere to come work here because ‘the local applicants don’t have the skills we need.’

    • notsplost says:

      The problem with politicians like Isakson is that they suffer from a huge credibility trap. As the original post states, Johnny made his fortune off a system that has been revealed to be a failure. Now that he is in a position of power he is being asked to solve a problem that is partially of his own making. Good luck with that.

      The whole “originate to sell” model of mortgage financing seemingly worked during the boom and made lots of people rich (bankers, brokers, and those lucky or quick enough to get out before the crash.) However, the notion that banks were reducing risk by getting loans off their books turned out to be false. The risk was only hidden and moved to other places – pension funds, small investors and now the government itself. The only way to ensure a stable system moving forward is to head towards a system of “one dollar of capital for one dollar of lending”. Once you allow credit to be issued un-backed by any tangible asset, that is an implicit act of theft. The theft may stay hidden for a while, but eventually the truth will be revealed.

  3. Doug Grammer says:

    20% down is a huge sum. I would feel more comfortable with 8% of money from the borrower with no gifts of equity or down payment funds. I think the longer government plays games with the mortgage industry trying to fix it, the worse off it becomes.

    • John Konop says:

      In all due respect:

      Down payment does not equate to value. Last sale ie comp value does not either via sale price changing quickly and multiple variables. Rental value even in down economies stay fairly consistent, and if average rent time is long than the person should put a lot of money up because a sale is the only way out if they have income problems.

    • saltycracker says:

      20% down – That applies to loans the lender is planning to securitize. It’s a good check.

      The rent/buy ratio today is a good benchmark to buy or rent. But if we make that a lending regulation, politicians will manipulate it. For example, Dunwoody could severely restrict rentals to upscale properties or Buford could allow any land for apartments, driving down values and driving taxes up.

      Why not just return to sound lending practices, full income and capability checks, equity positions, interest rates in the 7% range and no tax benefits for debt.

      I’m no Isakson fan because of his $8k handout, but got to go with him on this one.

      • John Konop says:

        …….But if we make that a lending regulation, politicians will manipulate it. For example, Dunwoody could severely restrict rentals to upscale properties or Buford could allow any land for apartments, driving down values and driving taxes up……….

        First counties do this anyways and it does bite them via supply and demand. Second I agree verify income ratios should be part of any lending program and was one of the biggest issues we had………… Finally rental value is not the end all but it is a better check than down payment. One of the reason I predicted the down turn way in advance was when I saw irrational levels of home/commercial values verse what you could rent it for. Rent values on a macro tie back to wages ie what people can afford. That is the best macro long term check on property. I have always advised people when buying property it less important how much you put down relative to, can you rent after the down payment in a timely manner if you have no choice. If you are at the price points you have many options…………If you upside down on rental and market turns life is tough……………….

        • saltycracker says:

          So what P/R ratio would you suggest ? As being involved in the Florida rental market for a long time these ratios are crazy volatile. A lot of folks saw the mess coming, some got out way too early, some good folks stayed too long, some of us cut back but kept some skin in the game for a lot of personal reasons. The stupid, gullible, or in most cases, the duped by professionals, leveraged up and stayed too long.

          The P/R ratios vary greatly by market in the most stable of times, whatever those are, due to short/long conditions and a changing tax environment. Kinda like tieing up to a stationary post in a 7′ tidal area. Rental rates are crazier than sale prices.

          • John Konop says:

            Salt,

            I am talking about a basic book value done all day in business. You factor in rental rate, time on market and vacancy verse the cost of leverage This is basic model we use for business valuation. Anything above that is a premium in which if you lend on it that is risk.This concept is used for any business with a few variables changing depending on the concept. The strength of current revenue against your cost is how you figure out book value. This is much safer than last sell concept which factors in market premiums which does not many time correlate to revenue. And we just saw even high down payments does not protect lending against irrational revenue lending not factoring net revenue.

  4. gcp says:

    Agree with Isakson on FANNIE/FREDDIE phase-out. Now can we please phase out FHA and get government out of the real estate business. FHA has over $1 trillion of loan guarantees outstanding and we don’t need more. Doubt if Isakson will agree as he was a strong backer of the wasteful Homebuyer Tax Credit Program from a couple years ago.

    • John Konop says:

      The problem is that if will pull out now it will hurt property values. And since we tax payers are on the hook we would be shooting ourself in the foot if we cannot replace it with a viable solution. As you know I warned years ago about tax payers being on the hook and many laughed, but not now. But like Iraq you break you own it. And this is why we need a pragmatic solutions, not crash the plan and hope somebody survives.

  5. gcp says:

    The housing market already crashed. Of course we must honor outstanding debt but issue no new fed housing bonds, notes, strips and whatever else they peddle.

    • John Konop says:

      Property would crash further ie supply and demand if we did not have lenders at close to the current deal. That would jump unemployment which would put the problem on steroids.

        • John Konop says:

          Absolutely!! The reason I recommended rental value is that would help control irrational values. Property inflating faster than wages fueled by irrational leverage is one of the ways we got into this mess.

          • saltycracker says:

            See above on rental rates – moving back to economic reality is by returning to sound lending practices, normal interest rates and stablizing government influences.

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